No one wants to overpay for their home, and buying a home in a competitive market often leads to offers above list price. But how can you both write an offer that positions you to win the deal, without needlessly overbidding? That’s where purchase price escalation clauses come into play. Using an escalation clause in your offer is the best way to write an aggressive offer while hedging against overpaying, and I’m going to teach you everything you need to know about them in this blog post
If you’re buying a home in a competitive market, you’ll need a strategy to help position you to win the deal, and while you always have the option of offering the absolute max you’re willing to pay for a home, that can often lead to paying more than you would have to, if your max is significantly higher than the competition. While there will always be people who are ok with that, as long as they lock down their dream home, most buyers would prefer to not pay more than they have to in order to win the deal. That’s why having a strategy that allows you to still put your absolute best foot forward, while hedging against the competition not having as high a ceiling as you is extremely important when writing an offer on a home. This is exactly what the escalation clause does.
So what is an escalation clause? An escalation clause is an addendum to your offer that tells the seller you’re willing to beat the next best offer by a certain amount, up to a certain amount. In order to use an escalation you need to know two things. First, what’s the max you’re willing to pay for this house? And second, by how much are you willing to beat the next best offer by? These two factors will determine whether or not you position yourself to win the deal. Of course, there are other factors that go into an offer, but these are the big ones. When we use an escalation, it’s important to note, that generally speaking, we’re calculating off the seller net. This can make things a little more complicated if one of the offers is requesting closing cost assistance, but for the sake of this video we’re going to leave closing cost assistance out of it. The easiest way to show how an escalation works is to run through an example of how you might use this.
Let’s say you’re planning to write an offer on a $500,000 home. You know there will be multiple offers, but you absolutely love this house. You’re willing to pay up to $550,000 to get this home. You’re also willing to beat the next best offer by $5,000 up to that amount in order to get it. So you write an offer for $500,000 that includes an escalation clause that outlines the fact that if someone else writes an offer that’s $500,000 or higher, then you’re offer will automatically increase to $5,000 higher than whatever their offer is, as long as it doesn’t push your final purchase price over $550,000. So, for example, if someone else writes an offer for $530,000, then your offer automatically goes to $535,000. Assuming other factors are the same, this put you in a great position to win the deal without having to go to your max price of $550,000 and saves you $15,000 on the principal purchase of your new home.
Now, If no one writes a competing offer, then your offer stays at your initial price of $500,000. And if someone writes an offer for over 550 then, unfortunately, your offer will be outbid since yours doesn’t go above 550. That’s why it’s very important to make your cap, your true cap. Sellers may not give you the opportunity to improve on that number in a competing offer situation, and the last thing you want to have happen is lose out over a few thousand dollars because you didn’t put your best offer in when you had the chance.
In that example, I used $5000 as the increments we went up by, but this number can be anything you want. It tends to get higher, the higher the sales price is. I’ve seen it as low as $100, though in that case the seller found it laughable and didn’t take the deal. But it’s common in our area on lower priced homes to see it at $500 on lower priced homes and 10-20,000 or even more on higher end homes. The key is find an amount that would make a big enough difference to the seller so they pick your offer over the other one. Sometimes just a few bucks isn’t enough to influence a seller if there are other factors in play, like ideal closing date, or shorter home inspection period…something like that.
There are other factors to consider when using the escalation clause. First, you need to make sure you’re approved for the full amount. You’ll want to include a pre-approval letter from your lender for the full escalation amount along with your offer. This shows the sellers that not only can you afford the house at list price, but you are definitely qualified for your max amount. You’ll also want to run the numbers to make sure you’re comfortable with how the escalation affects both your down payment and your monthly mortgage amount. Just because you qualify for the max, doesn’t necessarily mean you’re going to be comfortable making the payment every month. The final factor is appraisal. Bidding well over list price is great and all, but if you’re getting a mortgage, you’ll still have to appraise for the sales price or you could potentially lose the deal. In a previous video, I discussed appraisal gap guarantees as a way to protect against this, and you can learn more about those here.
One question I always get when writing an offer with an escalation is, won’t this tell the seller our max and could they use this against us to get us to pay more? The real answer is…only if you let them. There are absolutely situations where a seller could say, hey we’re planning to take this other offer, but we see you’re willing to go higher than where your escalation currently puts you. If you go to your max, or instead of $5000, go $10,000, then we’ll go with you instead. At that point, the ball is in your court, and if you’re willing to do it, then go for it, and if not, stand firm with your offer the way you wrote it and let them decide. I recently had this happen with a buyer – the competing offer was all cash, so they said if you’ll go 10K over them, then it’s all yours. She said sure, because it was still below her max, and now she lives in a gorgeous home a block off the beach.
The other big question I get is, how do I know they’re not lying to us? What if there is no competing offer? Well, the good thing about our purchase contract is that when using the escalation addendum, the listing agent is required to provide the competing offer that shows exactly how the escalation came into play. So we’re always going to be able to verify that we aren’t being deceived in any way. That may not be true everywhere, so if you’re buying a home outside of southeastern Virginia, then you’ll definitely want to discuss this with your agent.
So there it is, the purchase price escalation. This is absolutely the best way to write an strong offer, without wildly outbidding your competition. No one likes overpaying for anything, and in a competitive market you may already be a little taken back by why you need to offer to be competitive, so throwing away extra money on top of today’s high home prices can really hurt. The purchase price escalation will help protect you, and your investment, while positioning you to win the deal!
If you have any questions whatsoever, please call, text or email me any time!